x Abu Dhabi, UAESaturday 20 January 2018

Consumers will act badly until debt laws are reformed

Decriminalising bad debt in the UAE would minimise credit default risk, reduce government resources devoted to tracking down debtors and increase economic efficiency.

Defaulting on personal debt is a criminal offence in the UAE, a fact most recently evidenced in the pardon of almost 7,000 Emiratis by the president, Sheikh Khalifa. Their debts, amounting to a hefty Dh2 billion, will now be paid by the government.

This was undoubtedly an act of generosity by the UAE's leader. But it was also a potent reminder of just how outdated this country's debt laws are.

The current practice of obtaining loans or credit cards by posting a cheque as collateral with the issuing bank is highly inefficient because it doesn't take into account the consumer's creditworthiness in determining how much debt he or she can handle. If the consumer defaults, the bank can use the cheque to transform the case into a criminal matter.

Banks may eventually recover some of their debt, but making default a criminal offence impedes the ability of good-faith debtors to repay. Moreover, being in debtors' jail or absconding from the UAE only makes it more difficult for banks to recover funds.

There are several ways in which the entire policy framework of credit and debt can be revised to address these oversights.

At the macroeconomic level, lending should be channelled to activities that provide the highest rates of return. Since retail is one of the pillars of economic activity in the UAE, bank lending should naturally cater to this sector. But it must do so with due diligence.

This is typically the role of credit bureaus in the US, for-profit organisations responsible for formulating and issuing credit reports on individuals based on both a consumer's credit history and the manner in which the consumer is managing his existing debt burden.

The UAE has a functioning credit bureau in Dubai called Emcredit, which gathers data on both individuals and firms for use by the private sector. This scheme is currently being extended to the federal level as announced in mid-summer 2011 by the Ministry of Finance.

The task of credit bureaus in the UAE, however, is complicated by the transient nature of the foreign population, with workers whose previous credit history is difficult to uncover or obtain. Once a federal credit bureau is functioning, lenders will have access to country-wide intelligence on individuals' bounced cheque history; banks will be able to cross-reference this information with individual-level characteristics.

But the particular nature of the UAE credit market also points to the need for additional regulation forcing banks to make a good faith effort in collecting credit data from consumers pertaining to their credit history from their countries of origin.

Decriminalising bad consumer debt should fit into a framework of broader regulatory reform, one that takes into account incentives faced by both banks and consumers that nudges them to avoid problems of moral hazard.

In this regard, the UAE can learn from the reforms of other nations, notably those undertaken by the United States.

Consumer debt has helped fuel the world's ongoing financial crisis, and economists remain concerned about the viability of US economic growth on the back of excessive consumer borrowing. Indeed, while the International Monetary Fund has not downgraded its forecast for US economic growth in 2012 (unlike the euro zone), the Federal Reserve has recently noted that consumer private debt had bounced back to its pre-crisis levels.

In 2007, many economists blamed mortgage brokers, whose attractive loan packages encouraged risky investment. But they also blamed credit card issuers, whose teaser rates encouraged consumers to roll over their debts instead of exercising caution.

Both mortgage and credit card debt were also important elements in fuelling the speculative asset bubble in the real estate sector in Dubai.

Following the 2007 real estate crisis, US authorities tightened regulation on mortgage brokers (the Dodd-Frank Act passed into law in 2009 established a new financial regulatory framework to deal with both the consequences and causes of the crisis).

In addition to establishing a framework for deleveraging bad debt, the act also required brokers to check the ability of borrowers to repay, which in turn may be used in future litigation by the borrower in his defence, and limited the broker fee structure to be essentially based on the value of the principal amount being lent rather than specific loan terms.

Implementing similar reforms in the UAE would minimise credit default risk, reduce government resources currently devoted to tracking down debtors and increase economic efficiency by channelling funds in sustainable and wealth-creating economic activities.

It would also, by default, keep people out of jail.


Tarek Coury is chief economist at Tanween, a real estate firm based in Doha, Qatar

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